Taxation and Fairness

Now on to Barton Hinkle’s second big point in his effort to dissuade readers that economic inequality is a serious issue: the question of taxes, and who pays them.

Hinkle cites data indicating that the top 1% pay over 30% of all income taxes (the exact percentage in 2003 was 34%)  as evidence of the progressive nature of our tax system. 

That is a valid statistic, but looking at it out of context paints a seriously misleading picture. Five crucial points in particular need to be stressed.

First, the top 1% of the income distribution garner (as of 2003) over 17% of all income reported to the IRS. As the overall distribution of income becomes more unequal, the proportion paid by the top 1% should increase as a matter of simple math. Put another way, statistics about the proportion of taxes paid by the richest say as much about the highly unequal overall distribution of income as they do about the tax code.

Second, following from this observation, the best way to get a good picture of how progressive the tax code is to look at the actual rates. Doing so reveals that income tax policy has been getting steadily less progressive over the past 40 years; rates on the richest have fallen from 77% as late as the 1960s to just 35% today. (Bush I and Clinton succeeded in raising the top rate from its Reagan-era low of 28% to first 31% and then 39.6%.)

Third, income taxes account for just under half of all federal revenue, and looking at them alone provides a distorted picture of the actual tax burden. Most significantly, social insurance taxes, which account for some 37% of all tax receipts, are essentially regressive: a fixed rate is paid on all income up to a ceiling ($87,000 in 2003); income above that line is exempt. Looking at this bigger picture, the Congressional Budget Office reports that the top 1% paid just 20.1% of all federal taxes in 2004–a percentage only slightly higher than their share of overall income.

Fourth, the effective tax rate on corporations has been falling for decades, with corporate income taxes now accounting for just over 10% of federal revenue, down from as high as 32% in the 1950s.

Fifth, and most pertinent for the question at hand (does the U.S. have an inequality problem?),  after-tax income inequality has grown steadily in the past generation. In 1980, real after-tax income for the poorest quintile of Americans averaged (in 2003 dollars) $13,000, compared to $305,800 for the richest 1%. By 1990, the figures were $13,100 and $520,000, respectively; in 2003, the figures were $14,100 and $701,500.

Here, then, is the bigger picture: however progressive the income tax system may be, it hasn’t come close to offset the effects of the massive increase in overall economic inequality over the past generation. Moreover, looking at the income tax in isolation from the rest of the federal tax structure leads to a dramatic over-estimate of the system’s overall progressivity.

What is a fair tax rate for the rich to pay? The answer to that question depends on the answer to a prior, more fundamental question: Is the distribution of (after-tax) income generated by our economic system consistent with maintaining a society based on equal citizenship and the provision of substantive equality of opportunity to each of its citizens?

If the answer to that question is “no,” that higher effective taxes on the rich have to be considered seriously as one important strategy for correcting that imbalance and leveling the playing field. 

The place to start is not even with the top 1%, but with the richest of the rich, the top 0.1% of all taxpayers. As David Cay Johnston of The New York Times has documented, the effective tax rate paid by those select households actually declined from 1992 to 2000. Persons at this level of income hire tax evasion specialists who help them arrange their assets in ways that the federal government can’t get at them very easily, and they can claim all manner of perks and tax breaks unavailable to the working stiff.

By far the best source on the topic of how the super-rich evade income taxes is Johnston’s 2003 book Perfectly Legal; for a detailed look at the related issue of tax evasion by the rich and well-connected, see this book edited by economist Max Sawicky.

The overall picture that emerges from Johnston’s work is that the political capacity of the super-rich to manipulate the tax system in their favor has increased in lockstep with the overall increase in economic inequality, with each trend reinforcing the other. I hope Jim Webb has read Johnston’s book; calling a few hearings in 2007 on some of the most remarkable abuses of the tax system by America’s most wealthy would be a good move by the senator-elect and a necessary first step towards reform.

Next time: Why should we care about inequality at all?

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Published in: on November 26, 2006 at 4:46 pm  Comments (6)  

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6 CommentsLeave a comment

  1. Excellent post. I hope lots of people read it.

  2. […] While I don’t live in Richmond, I do occasionally read the Times-Dispatch online. But Dr. Williamson’s posts are not completely Richmond-centric. Take, for example, his post entitled Taxation and Fairness. While aimed at Barton Hinkle, Dr. Williamson takes on the issue of income taxes and lays out a well-researched argument. The overall picture that emerges from Johnston’s work is that the political capacity of the super-rich to manipulate the tax system in their favor has increased in lockstep with the overall increase in economic inequality, with each trend reinforcing the other. […]

  3. So glad to see the citation of Johnston’s book Perfectly Legal, which I had intended to call to your attention after the last post. His income distribution graph showing the relationship of the top .01% to the rest of us would make a great exhibit at a hearing, and a good poster for every refrigerator in America.

  4. “Is the distribution of (after-tax) income generated by our economic system consistent with maintaining a society based on equal citizenship and the provision of substantive equality of opportunity to each of its citizens?”

    Would you mind expounding on the above? What would you consider a “society based on equal citizenship”? What do you mean by “substantive equality of opportunity”? In other words, what would such a society ‘look’ like, income-wise?

  5. “Fourth, the effective tax rate on corporations has been falling for decades, with corporate income taxes now accounting for just over 10% of federal revenue, down from as high as 32% in the 1950s.”

    How would you reverse the decline? From whence will come the additional taxes corporations would pay?

  6. […] The first is an extract from this site’s post on Taxation and Fairness, stressing the fact that social insurance taxes are regressive, which offsets the progressivity in the income tax. The second letter, making almost the identical point, is written by Lee Hollett of Ashland, who used tax software to compare the estimated tax burden of a minimum wage worker and corporate executive. Published in: […]


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